Normalization of Earnings is Essential to Privately Held Dealerships, Even if You are Not Selling
By Phil Villegas
For most dealers, knowing what their dealership has earned in profit is a simple matter of looking at their dealer statement. For other dealers, they realize the dealer statement is not the final score and they wait to see the results of their CPA reviewed or audited financial statements to know what their actual profit was.
In either scenario, if all of these dealers above were to sell their dealerships, there is a remarkably high probability these dealers would neither use their dealer statements or CPA financials as the sole basis for determining the valuation of their store. When it comes to doing a valuation of a dealership or any other business for that matter, it is essential to complete an earnings normalization analysis in helping to arrive to a true net-profit from operations. In basic terms, a normalization analysis is looking at “Addbacks and Deducts” to the dealer’s profit that could be considered non-operational, non-recurring, or unsustainable in nature. Some examples of addbacks and deducts to a dealership’s income can be:
Off the books income
Tax efficiency items
One-time or extraordinary events
13th month adjustments
The end goal is to add back or deduct these items to the dealership’s reported income so that you can arrive at what can be considered a truly normalized profit number. This normalized number will then become the basis of the multiplier that will be applied in arriving at a valuation.
While the importance of the normalization exercise is clearly apparent when selling a dealership, its value is less apparent and unfortunately overlooked for dealers with no plans of divesting. We find that unless the dealership owner is a true operator working in a General Manager or similar capacity, not conducting periodic normalization exercises (every year or two) may be costly.
The value in completing a normalization analysis for owners even if they are not selling rests in having an objective viewpoint of the actual performance of the dealership as stand-alone business. Over the course of time, dealers tend to allow a financial status-quo to remain in place while at the same time weaving in numerous profitability impacting measures that only go to obscure the actual profitability of a store. From not recording market rent to packing F&I products as an example, dealers create a less than objective financial picture of a dealership which fails in being truly represented in a dealer financial statement or CPA financial.
Besides providing a dealer an objective valuation basis, a normalization analysis enables an owner to take a step back to evaluate the stand-alone earnings of the dealership and how some individuals may be getting compensated on those earnings. With most non-operating dealers, we tend to find general managers, platform presidents, COOs, directors, CFOs, controllers, etc., who’s compensation is impacted by the bottom-line profitability. Whether the calculation is derived from a dealer statement or CPA financial, neither of these tend to fully consider the impact of normalizing events and may reward individuals financially on matters they have no control over.
While some dealers may feel the advantage rests on their side in terms of the addback/deduct equation, the reality is we tend to find individuals being the financial beneficiaries of certain earnings decisions. From charging operational items to the 13th month, lower than market rent, over-capitalization of the dealership as examples, all leading to larger bottom line which will ultimately be discounted in a real-world environment. As I have told other dealers in the past, if you are not getting paid on it, why should others!